The Riksbank has long carried out stress tests of the banks’ capital and liquidity to assess the resilience of the financial system to various types of economic disruption. As the financial risks associated with climate change have grown, the Riksbank now also has an interest in analysing the climate-related risks that may affect the banks. In the near term, transition risks are likely to be the most acute of these.
Such an analysis could be done using scenario analysis, or climate stress testing, which involves estimating the impact on the banks' balance sheets and profit and loss accounts in a severe financial scenario. The scenarios commonly used in stress tests typically describe a sharp downturn in the economy over a period of up to three years. To estimate how such downturns would affect banks, or other institutions, we use various models and historical data on institutions’ balance sheets and profit and loss accounts. In this way, banks are ‘stressed’ and the results of the models are used to calculate the banks’ hypothetical liquidity needs or loan losses.
The Riksbank is developing an analysis of how a sharp increase in the price of emission allowances could affect the banks through their lending to non-financial corporations. The stress test is based on data on the banks’ lending to these corporations, the corporations’ balance sheets and data on their carbon emissions. Using this as a basis, the Riksbank then models the probability of corporate bankruptcy, along with how this affects the banks’ capital adequacy.